Germany in 2023 – the murky chrystal ball?

“Germany had outsourced its security
to the United States, its energy needs to Russia
and its export-led growth to China.

Constance Stelzenmüller (here)

Even more so than in previous years, which were in some cases full of corona, a look into the chrystal ball regarding Germany’s economic development in 2023 turns into a strained poking in the fog. Too many factors can drive developments in one direction or the other. But even if 2023 turns out to be more positive than expected – moderate economic growth with easing inflation – the signs for the years thereafter are not positive. As the following post will show, in just over twenty years Germany has merely gone around in circles once – at least as far as political goal-setting and economic resilience are concerned – without solving the problems of the time in a sustainable way.

1. The economic development in 2022…

First of all, however, it should be noted that the German economy still grew by 1.9% in 2022 despite the remaining Corona effects, the consequences of Russia’s unlawful attack on Ukraine and the resulting consequences, particularly in the area of energy supply (here, cf. also here for the respective current development). Although this is far below the growth rates of 3.5% to 4.9% predicted by the experts (here, p. 394 or 10 of the pdf, in German), it is not bad in view of the aforementioned negative effects on growth

2. …was debt-driven

However, a not insignificant part of this growth was probably bought by new debt. The officially stated new debt for 2022 of 115.4 billion euros (here, in German) was already the third-highest new debt ever incurred by the federal government (here, in German). On top of this, however, there are 300 billion euros in so-called “special assets,” such as for equipping the Bundeswehr. The effective debt of the federal government thus increased by 415.4 billion euros in 2022 – with a budget volume of 476 billion euros (here, in German).

And the national budget is growing relentlessly, from just under Euro 300 billion in 2015 by more than a half to the aforementioned Euro 476 billion (here, in German). In the same period, however, tax revenues have only risen from Euro 673 billion to Euro 833 billion (here, in German), i.e. by around 25%, with the so-called “cold progression”, which is now perhaps even driven by inflation (see below on the subject of wages and salaries), probably playing a not insignificant role in this. In view of these bubbling revenues and the as yet insignificant cost of debt (but see here, in German), inflating the national budget is currently an easy way to avoid conflictual decisions, and not only for the treasurer, Mr. Lindner.

3. … and has pushed the public spending ratio.

Not entirely unexpectedly, the “double whammy” of the federal government (original statement of Mr. Scholz, here, in German), which is also included in the new debt, may have played a not insignificant role in the increase of the public spending ratio to over 50% (here, in German). The “3 times 40 program” of the former Bavarian president Mr. Stoiber from his election campaign 2002/2003, that among other things foresaw a state ratio of “only” 40% (here, in German) seems there like a dream from an old for a better world. Given the current development of basic economic data in particular, it also seems not unlikely that the public spending ratio will continue to rise in the coming years – politicians are likely to be concerned about maintaining the “prosperity illusion” (Daniel Stelter) by expanding the “public spending ratio” to compensate for the dwindling “economic ratio”.

4. Economic growth in 2023 will remain meager…

If you believe the pundits at the economic research institutes, the German economy is likely to grow by 0.3% at best in 2023 (IfW Kiel, but they were already completely off the mark in 2022) and shrink by -0.75% at worst (IW Cologne) (here, in German). German bankers, on the other hand, are much more gloomy about the future, ranging from -0.5% (Commerzbank) to -1.9% (DZ-Bank, see here, pdf p. 34, but DZ-Bank is currently much more optimistic about the future, here, both texts in German)

5. … and could become even more mediocre in the years to come.

Almost irrespective of how the German economy will actually fare in 2023, longer-term indicators show a clear downward trend: Germany’s innovative strength, for example, is mediocre in an international comparison, as Die Welt reports here (see also here, both texts in German). Due to the energy crisis, there were already indications at the beginning of November 2022 that quite a few manufacturing German companies could turn their backs on the country (here, in German). Current – sharply declining – production figures of energy-intensive industries (here, chart 6, in German) at least allow the interpretation that German industry did not limit itself to panic-mongering. If even the German Confederation of Trade Unions (DGB), which is not exactly suspected of being overly friendly to capitalism, warns of a de-industrialization of Germany (here, in German), this topic is likely to be a key issue for the rest of the decade. After all, Germany is already being pushed down in international location rankings (here, in German).

6. The Germans’ “prosperity illusion” is in danger of bursting….

It therefore does not seem far-fetched that these developments could extend the slight dampener in the Germans’ national prosperity index (here, in German), which has so far been caused by Corona, into a crash. Last year, for example, Germans suffered their third real wage loss in a row, even though wages were rising at a record pace (here, in German). To make matters worse, in a Europe-wide comparison, particularly little of the (future) increase in wages will reach employees in Germany (here, in more detail here, both texts in German). In other words, we have the highest gross pay for employers and the lowest net pay for employees in Europe – not even Switzerland or Luxembourg do so badly (again here, in German). And on top of that, the tax burden on top earners is much higher than on the bottom 50% of taxpayers – the top 50% pay 93.9% of income taxes, the bottom 50% only 6.1% (here, in German). And in this situation, the (partly newly appointed) panel of top economic experts (Germany’s “”five wise (wo)men” as they are aptly named) call for tax increases for the top income earners (here and here, both in German)? Even before, these pundits have not been the greatest forecasters under the sun (here, in German), but to call for tax increases in the face of a looming recession and in view of the previously presented government spending ratio and the resulting discrepancy between gross and net wages is not “wise,” to put it diplomatically. Perhaps these leading economists should take a look at the expenditure side, just a thought. Because, as the ifw Kiel writes so well, “redistributive spending dominates the federal budget” (here, in German). At the same time, analyses have shown that the state has been investing less and less in future projects for years (here), i.e. consumption takes precedence over construction. And this closes the circle (or the downward spiral, depending on your point of view): Because the lack of investment will cause Germany’s aforementioned declining innovative capacity to fall further – and counter-incentives, such as higher taxes, will accelerate this trend. And the state – in order to maintain the “illusion of prosperity” – is then likely to “readjust” with further redistribution programs. Which then leads to an acceleration of the downward spiral, etc.

7. …partly due to inflation-driving aid programs.

This “readjustment” is also likely to “fuel” another hot topic in 2022: inflation (see here for the current status, in German). Although the inflation rate in Germany fell back into the single digits at the turn of the year, this is no reason to sound the all-clear. The banks’ forecasters (cf. above in the citations regarding economic growth, in German) are all predicting an inflation rate of more than 5% for 2023. That is light years away from the ECB’s stability target. And even the achievement of this inflation rate is likely to depend on another black swan not appearing in the firmament. Accordingly, the value of the statement by the head of the Federal Network Agency (“Bundesnetzagentur“), Müller, that he no longer fears a gas shortage this winter (here, in German) cannot be overstated. But although the price of oil has long since fallen back to pre-war levels (here, in German), we are still paying higher prices at the gas station than in January 2022 (here, in German). Whether this higher price – as well as other high prices – is related to a “greedflation”, as Mr. Müller (here (in German), the one from Der Spiegel, not the one from Bundesnetzagentur) claims, i.e. whether the current inflation rates are more driven by the profit motive of companies than (still) actual price increases for energy, raw materials and intermediate products, I cannot judge. But I would not rule it out. If this were to be the case, the government aid – which is once again being poured out with a watering can – could once again go to fat cats rather than to those actually in need. At the same time, the expansive FISCAL policy is likely to counteract the ECB’s now finally more restrictive MONETARY policy. In other words, while the ECB is acting to lower inflation, the German government is acting to drive up inflation (see also here, in German).

And the so called “second-round effects” now also seem to be just around the corner. While the postal union’s wage demand amounting to 15% (here, in German) may stand out, other industries are not so far behind (here, in German). This inflation-driven wage-price spiral is likely to be further accelerated by the demographic change currently hitting the German economy with full force: On the one hand, more and more workers are retiring, putting a strain on social security systems (cf. here and here, in German), even though pension insurance generated a surplus in 2022 (due to corona) (here, in German). On the other hand, fewer and fewer young people are striving to enter the workforce (here, in German). The few who do come can dictate their terms. An adequate wage (see here for average earnings, in German) above the rate of inflation is likely to be only one factor. In other words, here, too, there are drivers lurking that may not immediately bring the inflation rate to the rates of 1923, but can at least keep it well above 5%.

8. the German economy is split in two,…

But it’s not just the wage and salary demands – like the still-high energy costs – that will cause trouble for German industry in 2023, which currently seems to be divided just like the rest of German society: There are the DAX companies, such as Siemens, which are rushing from record to record despite (or perhaps even because of?) the multi-crises (here, in German). In contrast, the German Mittelstand does not seem to be doing too well after the pandemic (here, see also here, in German). The question is whether this dichotomy, only roughly sketched here, will actually become more accentuated in 2023 or whether the German Mittelstand will be able to hold its own. After all, some of the DAX companies certainly have skeletons in their closets, such as inflated company values (here, in German), excessive debt (here, data from last year, in German), over-dependence on business in China (for example, BASF, here, in German) or even the siren calls of the USA (here, in German) – which may well have an enchanting effect, especially against the backdrop of increasingly dirigiste policies in the federal government and in the EU (see here, here and here for more details, in English!). Finally, the expected rise in the credit hurdle (here, in German) in the wake of the tightening key interest rate policy is likely to play havoc not only with the German construction industry (here, in German) over the course of the year.

9. …which could also be an opportunity.

But, just as the strong D-Mark drove the German economy from innovation to innovation in order to survive in international competition, inflation and energy scarcity could now give German (manufacturing) companies a boost in innovation and efficiency (see the Handelsblatt here with one of its rarely good comments, but also Mr. Müller from Der Spiegel, here, in German) Partly, this boost seems to have already taken place (here, in German). But whether this is really already enough for a “summer fairy tale”, as the Focus thinks (here, in German)? Maybe, but in view of the existing structural problems, that would probably be more of a flash in the pan ignited on the numerous governmental aid programs. Germany has gone too far in the wrong direction in the last ten years , as Mrs. Stelzenmüller rightly described, for such a misguided development to be corrected in one summer. Germany will have to reflect on its strengths – e.g., the small and medium-sized enterprises with their countless “hidden champions” (see currently here, p. 8 of the pdf, in German) – continuously rehabilitate and develop its infrastructure and give the population a perspective beyond citizen’s income, attitude and renunciation if it still wants to play a role at the end of the twenties of the 21st century.

Conclusion: Economic development in 2022 was debt-driven and pushed up the government spending ratio. Economic growth in 2023 remains meager and and could become even more mediocre in the years to come. The Germans’ “prosperity illusion” is in danger of bursting, partly due to inflation-driving aid programs. The German economy is split in two, but this could also be an opportunity.

So far, so mediocre. If you are old enough, this summary should remind you of “The sick man of Europe,” the legendary 1999 Economist title (here). For only superficially were the reasons for the former crisis different from the current one. Today it is Corona and Russia’s attack on Ukraine. Back then, it was (ostensibly) the costs and structural issues of reunification. Behind this, however, lies the constant theme of the expansion of social systems at the expense of economic development. In other words, in just over twenty years we have gone around in circles. Germany’s “Agenda 2010” (here) – now largely reversed – briefly slowed the erosion processes already underway at the time, which Mrs. Merkel was able to exploit for her “feel-good chancellorship.” But after the pandemic and the war, the old issues – social welfare, pensions, health – are once again confronting the dreamy German population unvarnished and unresolved. And the “peace dividend” has been used up – if it ever really existed.

In the early years of the new millennium, policymakers decided – in addition to the Agenda 2010 – to outsource Germany’s security to the U.S., its energy needs to Russia and its export-driven economic growth to China, to quote Mrs. Stelzenmüller again. In addition, Germany has outsourced its monetary policy to the ECB. The question is how German policymakers will now position themselves for the future in the face of the failure of all these decisions within twenty years. The prosperity of the next generations – and my pension – will depend on these decisions. In view of this, whether Germany escapes a recession or stagflation in 2023 is almost of third importance. It is much more important to use the numerous aid programs to establish sustainable economic prosperity for the future. In this context, the financial markets are likely to be skeptical of a steady increase in the national budget and the government share, while companies and – especially qualified – employees are likely to be skeptical of a steady increase in the tax share. In other words, contrary to the (populist?) advice of the “economic experts,” German policy will sooner or later have to tackle the expenditure side – without repeating the mistakes of the previous policy of “outsourcing” important utilities (illustrated here by the example of Berlin, in German) and creating a low-wage sector. On the revenue side, the government should not be able to get around setting an efficient and effective (caution, trigger warning!) inheritance and wealth tax – in order to turn back the taxation of labor. All in all, one could leaf through Ludwig Erhard‘s late work, “Prosperity for All,” which is admittedly dry as dust, or try to balance the “magic square” of “macroeconomic equilibrium” (cf. here, in German) according to Article 109 (2) of the German Constitution.

Can the incumbent government manage this mammoth task? As my fortune cookie said so well at the turn of the year, “The true art: expect nothing and appreciate everything.” Comparing the first years of “Brioni Chancellor” Schröder (cf. here) with the, shall we say, bumpy, start of the government under Mr. Scholz, we are left with the hope that he, too, will find his way into office – hopefully sooner rather than later – and tackle the structural problems with similar perseverance as Mr. Schröder did back then. Seen in this light, I will appreciate every step in the right direction. However, I no longer expect any step whatsoever.

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